The political economy of interregional competition for firms

This paper studies the impact of majority voting on interregional competition for firms. We model the competition as a first-price sealed bid auction under full information between two regions inhabited by low- and high-skilled individuals. The firm's location causes an increase in wages for the high-skilled. A region's bid is determined by the median voter's preference. We derive two results. First, the location decision may be inefficient because the firm may not locate in the region that benefits most. Second, if regional differences are sufficiently small and the median voter of the successful region is high-skilled, the winning region suffers a loss of aggregated income as subsidies exceed the surplus created by a firm's location. This implies that restricting inter-regional competition for firms, e.g. banning subsidies, may prevent inefficient location decisions.